KEY POINTS:
Inflation ran hotter than the Reserve Bank expected in the June quarter and the market now expects it to raise interest rates again next week.
Consumer prices rose 1 per cent in the June quarter. The bank had forecast 0.7 per cent and the median pick among market economists was 0.8 per cent.
The annual rate fell to 2 per cent from 2.5 per cent in March, but that reflected the June 2006 quarter's petrol-powered spike dropping out of the latest year's number.
The dollar shot up to US78.9c from US78.5c on the news and briefly touched a fresh post-float high of US79c in afternoon trading.
Short-term wholesale interest rates climbed, too. The money market now puts a 71 per cent probability on Reserve Bank governor Alan Bollard raising the official cash rate to 8.25 per cent next week.
A week ago they saw only a 25 per cent chance that he would.
"It's the second quarter in a row inflation has come in above the Reserve Bank's forecasts and we think it will happen again in the September quarter, despite the ever-strengthening New Zealand dollar," said Bank of New Zealand head of research Stephen Toplis.
The BNZ is forecasting inflation of 0.9 per cent in the September quarter, the Reserve Bank 0.6 per cent.
The strength of non-tradeables inflation was especially problematic, because that was the kind the Reserve Bank was supposed to have most influence on, Toplis said.
Yet it has been above 4 per cent on an annual basis for all but one of the past 15 quarters.
"We see it potentially staying there or thereabouts for most of the next two years unless domestic demand slows more than currently forecast," he said.
"The only way this will happen is if the bank raises rates further."
Petrol prices increased 8 per cent in the latest quarter, and electricity 3 per cent, but the overall increase could not be laid at their doors alone. Price rises were more widespread and on average larger than in the March quarter.
Among non-tradeable items, which are unaffected by world prices or the exchange rate, inflation remained sticky at 1.1 per cent for the quarter, compared with 1.2 per cent in March and 4.1 per cent for the year.
Tradeables inflation, at 0.9 per cent, was high as well. Most of that was petrol, without which it would have been only 0.1 per cent.
But clothing, major household appliances, furniture and second-hand cars all rose, despite the strength of the dollar, which should make imported goods cheaper.
"Businesses seem to be building up their margins rather than passing the benefits straight to consumers," said ANZ National Bank chief economist Cameron Bagrie.
Construction costs rose for the 33rd straight quarter and are accelerating, up 1.6 per cent compared with 1.3 per cent in March last year and 1 per cent in December.
The BNZ, ANZ National Bank, Westpac, Deutsche Bank and First NZ Capital all now expect Bollard to raise the OCR for a fourth time this year on July 26.
Deutsche Bank chief economist Darren Gibbs expects inflation to be back above 3 per cent by the end of the year.
"Neither last week's quarterly survey of business opinion nor the various consumer confidence surveys are pointing to the sort of weakness in the economy that would give the Reserve Bank a high degree of confidence that inflation will quickly fall back comfortably inside the target range [of 1 to 3 per cent]."
The last straw?
Since the Reserve Bank last reviewed, and raised, interest rates in June:
* Commodity prices, especially dairy, have continued to climb.
* Economic growth came in stronger than it had expected.
* Housing market data show only tentative signs of softening.
* Non-tradeables inflation remains stubbornly high.
